Markets were waiting eagerly to see what the US Fed Reserve would deliver in order to bring some cheer, even if temporary, to the global economy. The Fed Chairman Ben Bernanke brought relief on expected lines. He kept the Fed benchmark rate unchanged but committed to keeping it at the current level till mid-2015. This is a promise to keep monetary policy loose for a longer period. A decade ago it would have been seen as highly unorthodox that a central banker should commit to not increasing rates for nearly three years into the future! But we are living in abnormal times and, therefore, resorting to unorthodox measures. Since the US economy is not projected to come back to normal average unemployment rates?around 4-5%?for many years, the Fed has chosen to keep interest rates low till mid 2015. The other important measure?$40 billion a month mortgage bond buying programme?is aimed at reviving the housing industry in America which is seen as a significant driver of growth. The Fed has targeted the housing sector so that easy and cheaper finances are made available for home buyers. The intervention in the mortgage-backed security (MBS) market will also provide some relief to banks in whose books such securities are still lying at eroded values.
The markets across the world have predictably responded very positively. It may have helped that the Fed action comes soon after the German constitutional court verdict to support the eurozone bailout with requisite caveats. The European Central Bank statement a fortnight earlier that it will do whatever is in its power to prevent bond yields in eurozone flaring has also been good for market psychology. Yet, it must be stated that all such relief is merely temporary and will have no meaning unless real economies recover in the US and the eurozone in the next two years. It will, in fact, become counterproductive for the world economy if such liquidity keeps flowing into the global financial system and there is no concomitant growth in output and productivity. The central bank balance sheets of the US, the eurozone and the UK have grown by 232%, 149% and 307% in nominal terms between June 2007 and March 2012. This would increase further, after recent rounds of liquidity injection by the eurozone and by the US Fed, in the coming months. In effect, printing more and more money could worsen the situation,if this starts creating bigger asset price bubbles in oil, food and other commodities. We have seen how QE1 led to a 60% increase in oil prices over a period and how QE2 saw crude oil prices go up by 35%. This is not good for net oil-importing nations like India as it plays havoc with inflation, our fiscal balance and the oil subsidy regime, which are all highly politicised. India will have to view this aspect with serious concern as the Fed eases policy even more in future.
